Top Tips For Your End of Year Tax Planning

1. Pension Contributions

This year there are some interesting opportunities to make the most of the 2010/11 annual allowance of £255,000 before the tax year ends. However, be aware there are some unpleasant pitfalls for the unwary, so do speak to your advisor.

The old rule used to be that a pension contribution made by 5 April would save you income tax for the year. In 2010/11 that remains the general case, but the principle has been complicated by the new £50,000 annual allowance, which is due to take effect from 6 April 2011. The lowered annual allowance will replace the current special annual allowance. Also, with effect from 6 April 2011, the special annual allowance of broadly £20,000 is abolished. This could affect you if you have gross income of £130,000 or more in 2010/11 or either of the two previous tax years.

The way in which these two restrictions on tax relief interact is complex, not least because the special annual allowance works on a tax year basis, whereas the annual allowance revolves around pension input periods, which usually do not coincide with tax years.

2. Capital Gains Tax (CGT)

As the year-end approaches, it is worth taking some time to consider whether you should realize any gains and how to manage any losses you might have made.

Capital gains tax underwent a metamorphosis in the June Budget. The flat rate of 18% disappeared from 23 June 2010 and capital gains once again became taxable as the top slice of income. For gains falling into the higher (40%) or additional (50%) rate bands, the tax rate applied is 28%, while other taxpayers face an 18% rate. While the rate applied is determined by when the gain is realised in 2010/11, losses are not time sensitive and can be set against any gains made in the tax year.

Fortunately, the annual capital gains tax exemption was unchanged: it remains at £10,100. If you face paying CGT at 28%, then the exemption is worth £2,856. As 2010 was a fair year for most stock markets, it is worth reviewing your investment holdings to see whether to realise any gains.

If you do crystallise some gains, be careful about also realising losses before 6 April. Capital losses made in a tax year – even the uniquely split CGT year of 2010/11 – firstly have to be set off against gains made in the same tax year, with any extra losses carried forward to future years. If your gains alone would have been within your annual exemption, the losses are effectively wasted.

3. Inheritance Tax (IHT)

it is advisable to reassess the extent to which you use the three yearly inheritance tax exemptions before 6th April this year now that the nil rate band of inheritance tax has been frozen at £325,000 until 5 April 2015.

Before last year’s General Election there was the possibility that the IHT nil rate band would rise to £1 million. The Coalition Agreement put an end to any such hope, with George Osborne adopting his predecessor’s plan to freeze the nil rate band at the 2009/10 level of £325,000 through to 5 April 2015. With inflation still close to 5% and unlikely to fall in the short term, the five year freeze means that the impact of IHT will increase in the coming years.

It therefore makes sense to review the extent to which you use the three yearly IHT exemptions before 6 April:

The annual exemption.

  • Each tax year you can give away £3,000 free of IHT. If you do not use all of the exemption in one year, you can carry forward the unused element, but only to the following tax year, when it can only be used after that year’s exemption has been exhausted.
  • For instance, if you did not use the annual exemption in the last tax year, 2009/10, you can still use it by 5 April 2011, but only once you have fully used the 2010/11 exemption. Thus a gift of up to £6,000 (£12,000 for a couple) can escape IHT.

The small gifts exemption.

  • You can give £250 outright per tax year free of IHT to as many people as you wish, provided that none of the recipients is also beneficiaries of your £3,000 annual exemption. While the amount is small, if you have enough children and grandchildren the sum total of small gifts can still be more than the annual exemption.

The normal expenditure exemption.

  • The normal expenditure exemption is the least understood, but arguably the most useful of the yearly IHT exemptions. If you make a gift that is regular, out of income (not capital) and does not reduce your standard of living, it is exempt from IHT, regardless of its size. So, for example, if you decide to give away investment income, which would otherwise be reinvested, that gift should be covered by the normal expenditure exemption.

4. Savings Accounts (ISAs)

Do take advantage of the tax shelter benefits of ISAs. With the pension tax reliefs being cut again and the top rate of capital gains tax now 28%, do make sure you make the most of your annual contribution limit of £10,200.

ISA contribution limits will be index-linked from 2011/12, so this year’s limit of £10,200 (£5,100 in cash) will rise to £10,680 (£5,340 in cash) on 6 April. As the ceiling remains relatively modest and there are no carry forward provisions, maximising your contributions whenever possible is generally the best practice. With pension tax reliefs being cut again (see above) and the top rate of CGT now 28%, the tax shelter offered by ISAs has become relatively more important. As a reminder, the four main ISA tax benefits are:

  • Interest is received free of UK tax in an ISA, other than from cash held in a stocks and shares ISA (when a flat 20% rate applies).
  • There is no UK tax on dividends in a stocks and shares ISA, although tax credits cannot be reclaimed.
  • There is no capital gains tax on profits.
  • ISA income and gains do not have to be reported on your tax return.

With short-term interest rates still at historically low levels, the tax benefits of a cash ISA are small. While the ISA season will see variable rates of around 3% on offer for new savings, these rates almost invariably contain a large bonus element which falls away after a fixed period, typically 12 months. If you arranged a cash ISA a year or more ago, it is worth checking what interest rate your ISA is now earning – it could be 0.5% or even less. If you rely on interest income, you might want to consider a transfer to a stocks and shares ISA. You would lose the security of a capital deposit, but your income potential could increase significantly.

If you any questions about your end of your tax planning, please do get in touch on 020 3865 2379.

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